(cont’d from Part 1, here) …. things are never as bad as they seem
It was well before the execution of the Federal Reserve Act that a 40% gold reserve ratio already existed as a US Treasury requirement – whether mandated or via some natural evolution. In the early 1900’s, US money (stock and in circulation) consisted of legal tenders of paper and bimetals (gold and silver). We do know the US enacted a bill to maintain a minimum fund for the redemption of currency, but the physical reserves held over time go far beyond this.
From the 1902 US Treasury Annual Report, the ratio of gold to total stock of money listed in the range of 36.5 to 46.5 –
Here the historical ratio of physical gold reserves being 40% of the total money stock was evident at the turn of the 20th century. At this stage, gold served 2 purposes – being a bimetallic transaction currency for personal possession, as well as a physical/tangible stock backing paper certificates (as bullion). Is it reasonable to expect this ratio of physical to paper to change in principle? Of course, it appears to be arbitrary. Care is also taken by the US Treasury in reporting money stock (outside US Treasury) as per capita, being that the management of the total supply of money was linked in some fashion per capita (being both sensible and logical – since this would naturally cap inflation). Some sense of money and it’s capacity to do work (generate output) is evident in this relationship.
For example: A country that achieves $1Bn annual GDP with a money stock of just $100 per capita might be deemed more efficient / more advanced than a country that requires $500 per capita to achieve the same $1Bn GDP. However, total workforce population contributes to the total GDP outcome – using GDP per cap to money stock per cap is a direct measure of monetary efficiency. Expressed as a ratio (see below), higher is more efficient (more bang for buck), lower is less efficient (less bang for buck). The chart further below shows this relationship for the US spanning 1900 to 2011.
For completeness, the entire following page of the 1902 Annual Report is provided below –
(note the ratios in the right margin, in reference to physical gold and silver, expressed as a percent of circulation money stock) –
- The US Treasury called it a ‘gold factor’, expressed as a percentage of money stock
- This is a dual money system bimetallic, with limited paper (promissory?) notes
As established above by the US Treasury in 1900’s, 40% of the money base was to be held in account as physical gold reserve. It matters not whether the responsibility for maintaining physical gold reserves was listed within or without of the Federal Reserve System. We now know it has been removed from the Federal Reserve, however this physical reserve supports the credibility of all participants of the leveraged credit system, not just the US Treasury. Given the private profit/public loss mandate of failed US institutions via the Chapter 11 process, they are reliant on the ongoing capacity of the Governments (and hence their Treasuries) to continue to support delinquent banking practices. However this consideration is a digression away from the topic of gold.
- Establishing the prices of $20.67/oz gold; $1.29/oz silver
- Silver was not used by the US Treasury in calculating money stock reserve ratios
- As will be seen, the US reserves are to increase more than 10 fold into a peak in 1949
- Can extrapolate other gold ratios using per capita monetary data in the right margin
- Some currencies are substantially greater than 40% reserve ratio to paper at this time
- All future major global players maintained greater than 40% currency base at this time
- This was during an official ‘gold standard’ period
- Increasing to above 50% in 1913 and 1914. It eventually peaked in 1917 at 55.77% then dropped off sharply thereafter.
- Note money stock is greater than the money base, defined as money outside of the Treasury that is deemed to be in circulation. The difference is only 1-2%, which helps in this consideration of reserve to ‘monetary base’.
Comparison of ratios to money stock, and to money in circulation are shown below from 1920 US Treasury Annual Report – period 1910 to 1920 which spans either side of 1913, the year the Federal Reserve was created.
Remember the original 1913 Federal Reserve Act provides that
- every Federal Reserve bank shall maintain reserves in gold or lawful money of not less than 35% against its deposits, and
- reserves of gold of not less than 40% of its Federal Reserve notes in actual circulation, and
- not offset by gold or lawful money deposited with the Federal Reserve agent
- can maintain on deposit in the Treasury a sum in gold sufficient in judgement of the Secretary of the Treasury …
- that when the gold reserve held against Federal Reserve notes falls below 40%, the Federal Reserve Board shall establish a graduated tax … The tax shall be paid by the reserve bank …
So we can see where 40% originated from then. Was this fluke? Good management? Genius financial policy? Or was this precedence set by earlier trials and tribulations of earlier monetary regimes? I don’t know.
- indicating that the use of gold reserve ratios has been retained by the US Treasury, post Federal Reserve
- the ratio drops off sharply from 1917 with the proliferation of the Federal Reserve notes, as seen clearly in the bottom table above. Money stock now includes majority issues of paper currency commencing 1918 onwards.
- 1917 is also where the total stock of gold began to decline. There may have been good reason for this, but is worth noting. It appears to be a partial transfer to the Federal Reserve, until the Federal Reserve started to accumulate its own reserves – as per the original provisions of the 1913 Federal Reserve Act.
- The reserve ratio of gold stock began to increase again from 1921. US Treasury reporting notation “includes Federal Reserve bank holdings from 1918 and following years”
There is some discrepancy in the reporting during this transition in what was previously a stock of “monetary gold” in circulation to what became just “reserves” (monetary stock of gold), and how “money in circulation” was reported – as the numbers do not always reconcile from one year to the next (the reported numbers differ slightly, typically less than 3%)
The Annual Report states “The form of the circulation statement has been revised beginning with the issue for July 1, 1922, in order to show more accurately the distribution of the stock of money in the United States. On the new form of statement only money outside of the Treasury and the Federal reserve banks is included in circulation. The revised form of statement shows more clearly the distribution of the money held in the Treasury and the amount of money held by or for Federal reserve banks and agents.”
By 1930, the gold coin in currency had reduced substantially against the total gold held by the US Treasury and the Federal Reserve Bank. For clarity, 1930 summary tables are shown below –
- Note the reported ratio of gold to total money is back above 50% in 1930, after dipping following the introduction of the Federal Reserve System.
- The gold reserve ratio will reach peak above 70% in 1940, while physical gold reserve quantity (and value) peaks in 1949.
The peak in physical gold reserve holdings by value (and thus volume) will be in 1949, with $24.47Bn in bullion, being 699 Million fine ounces (21,740 tonnes!). If the US Treasury had kept this gold, it would be substantially more than is required as credit reserve in 2010 using open market gold prices. In 1949 US Treasury metrics, this was just 46.1% of money stock as per the historical table in the 1955 Annual Report below
- From 1950 onwards, the US Treasury ceased accumulating gold for its own reserves, and transferred some portions into a newly created credit support vehicle known as the IMF (International Monetary Fund)
- Tracking the transactions involving the IMF would mean it necessary to be fluent in the alphabet soup of external foreign exchange stabilisation projects and their interdependencies. This was not in my interests at the time.
I suggest also that the Treasury staff themselves failed to fully appreciate the benefits of a floating gold price until the US was ready (or perhaps forced) to do so much later on.
From 1955 Annual Report – At the Tenth Annual Meeting of the Board of Governors of the International Monetary Fund in September 1955, certain countries again proposed that the United States should raise the price of gold above its present $35 per ounce. In disagreeing with these proposals Under Secretary of the Treasury Burgess emphasized that an increase in the price of gold would be inflationary. It would also, he pointed out, be in sharp conflict with the aim of the United States to “maintain a sound currency as the basis for economic health, not only in the United States but also wherever the dollar is important”. (See exhibit 35.)
Gamesmanship perhaps? The US Treasury would have already known the outright benefits of allowing gold price appreciation, since this is precisely what they did in 1933 on account of circumstance more suitable to the US at the time. To allow other countries to benefit would have promoted easing external monetary policies that would have depreciated those currencies and made them more competitive against a comparatively stronger USD. At the end of 1955, the US held an impressive 619.4 million fine ounces (MOz, 19.26 tonnes) and were in a superior position financially expand its balance sheet as needed. Even so, more than half a century later, many countries are wondering at the role still expected to be played by the IMF and what benefit there is in trading was is essentially an intermediary fictional currency that is the SDR.
From 1945 to 1955 the total money stock outside the treasury was little changed rising only 10% in 10 years from $30.49Bn in 1945 to $34.32Bn in 1955. Likewise physical gold reserves were little changed rising 20% then falling 10% to settle slightly higher in 1955 than in 1945. This had no effect on the rapid recovery and rebuilding of post World War 2 USA as the excess money stock and superior financial position absorbed the rapid growth, thereby not needing additional base capital in order to stimulate the economy.
The above consideration of reserve backing of the US monetary base ignores all resultant private and public debts created separately and elsewhere (since debts and assets are meant to cancel each other, somehow … yet another tempting digression). By 1960, the physical gold reserve value ratio had fallen back into the 40% range, and from 1963 onwards was never to officially recover. From 1970 onwards, there was next to no change in the volume of physical gold reserves, but as we know now, with the US about to float the price of gold from 1971 the rising gold price was going to provide an unofficial bonanza.
Collating the values of US Treasury physical gold (now ignoring the role and period of the Federal Reserve) as declared in Annual Reports, the following chart can be derived –
- Since 1972, the ‘official’ price of gold remains at a Par Value adjusted $42.22; it is therefore worth noting the open market value of the gold reserves as held by the US Treasury since 1972 (above, dotted). It seems the US Treasury is yet to officially ratify a higher price of gold for reasons yet unknown.
- Gold price response after floating went to 100% reserve requirement in 1976, pre-1980 bubble
- Currently 43% of the required $1.081 Trillion reserve minimum. Either reserves increase 120%, or gold price rises 120% of $1750 to $3980 (last status price used for 2011 data point)
- The recent massive injection of monetary base caused the departure of the open market reserve converging to minimum reserve requirement. Now gold must increase 120% because of this; otherwise the reserve ratio would have converged in 2010 (unofficially of course).
Plotting the US Treasury money stock per capita against GDP per capita, we get an interesting relationship that alludes to a monetary efficiency, or capacity. I think others use this relationship as money velocity. Per capita chart below –
- Note, the change in ratio reflects the capacity of the monetary base to create output. I have labelled 2 generations of growth that seem evident from this plot. Will we see Gen3 from 2011 as a possible next upleg?
- From 1940 to 1982, I see this as the US currency having increasing capacity to do more work. Getting more bang for your buck peaked in 1982.
- Contrast the monetary excesses of 1940 low to 2011; the US Treasury in conjunction with the Federal Reserve now has a base of excess on which to build the next up cycle. It is only a matter of ‘when’ conditions present themselves. The money gun has been loaded.
This is where the events of 2008 become surreal. The real and sudden devaluation of the purchasing power of the USD has occurred through the recent and deliberate proliferation of PER CAPITA money stock (and hence leveraged credit). Over the course of 110 years, the base money stock per capita has gone from $26.90 in 1900 (yes, almost thirty dollars per person) to $8,317 in Dec2011. This is a 5.3% CAGR annual average increase in money base; oddly enough this is very nearly the same as the underlying CAGR of the DOW JONES index in the same period. Who would have thunk it? However, just in the last 4 years Dec2007 to Dec2011, money stock per capita has gone from $2,793 to $8,317, at a whopping 31.4% CAGR over 4 years! (That is a ‘wooshka’ moment for sure). By comparison, up to Dec2007, the per capita growth averaged just 4.4% per annum – which crudely accounts for 2% inflation/CPI, plus 2% average interest rate (as rent seeking). At first glance, this seems an outstanding accomplishment in sound money management spanning 107 years to Dec2007.
But in 2008, this situation changed dramatically to inject very large amounts of base capital into the financial system (a 207% increase in 4 years to 2011). The ratio dropped to all time lows, similar to the years following the great depression. So what changed all of a sudden? You can see the propping up of the financial system began with the easing money period of the Greenspan era. The ratio was already very healthy prior to the events of 2008.
The prescient warnings by 3rd US President Thomas Jefferson about the power and hostility that resides within US banking and its ability to disrupt Government contained in several letters to the US Treasury fully 200 years before the events of 2008 are worth researching. Still, it remains a perpetuating cycle of booms and busts, none more or less dramatic than those preceding – with the exception being the Great Depression of 1929-32.
Taking a stab, it seems most obviously the leveraging and the mechanics of the credit system is what has changed – but to be sure not so suddenly as to warrant such drastic increase in money stock in 2007. When you ‘gear’ (or lever) the money base in a credit system, you also leverage the growth. So if credit expansion has gone from a prudent (??) 20:1 to 40:1 (and more) then this doubles the effect, and adds 1% CAGR to the growth in the size of the total credit system, over and above the CAGR of the underlying money stock. But it is likely the cyclic nature of careless leverage and poor credit standards are much more responsible for the perpetuating boom/bust cycles. If you listen carefully, you can hear Jefferson laughing from beyond his grave. But such actions are universal, and it would be unfair to only paint the US with those brush strokes.
The principle of monetary soundness (credibility / credit worthiness) must surely remain.
It would be more than fair to hold a candle up to the accomplishments of the US Treasury over the 110 year period examined above (pre 2008) in maintaining a healthy and stable monetary balance sheet. The performance in light of a challenging and confronting global environment and the success of the development of the US during the period of 1900 to 1980 is truly remarkable. Other nations no doubt had a similar path of development, each succeeding in various differing aspects. Using ratio’s derived above of per GDP and per capita as benchmarks, it is then interesting to apply these as a pseudo-universal standard system for comparison of other sovereign participants. It’s not unrealistic to assume at least to some degree that other sovereigns were already, or had since begun using some aspect of physical reserves in supporting a similar reserve ratio during the development of their own monetary systems. The consideration above is only for the US from 1900 onwards – long after other systems had been tried and tested.
Using only global data for 2010/2011, the results are quite surprising. That the UK has recently sold 50% of its gold stock recently is a jaw dropper for this author. It is also going to be interesting how Japan handles her remaining stocks of gold reserve going beyond 2011, as these reserves are surely the last remaining capacity of Japan to shore up international credibility for the desperate situation she now finds herself. Japan is crowding into the thin edge of a wedge. Any country holding paper US Treasuries in this environment of negative real yields out to 10 year maturity is not even holding onto face value of that paper. This would provide another reason to select an asset that will provide at least face value return when returning zero real yields.
- Excluding all consideration of existing public and private debt, this is a base analysis
- Note excess position held by Germany, Italy, France, Portugal and Netherlands
- Lebanon has the largest excess reserve capacity by ratio to GDP and per capita
- Switzerland is the 2nd largest excess reserve by ratio to GDP and per capital
- At the top of the table are the bench mark positions of the global ‘powerhouses’
- Conversion of gold reserves to GDP and GDP to required gold reserves based on the derived historical ratios
- It is then possible to plot a path of sound economic confidence for the ongoing development of emerging market and BRIC economies
- Further correlation and historical examination can be performed on those countries who default, or are repeat defaulters, and relating to whether forced to or elected to do so; situations and outcomes differ from case to case
- In the absence of any global or local legal enforcement, the choices by every sovereign in maintaining sound a financial balance sheet are entirely internal on whether to default or not default on excess external debt.
Reversing ipso facto these leverages, it is then possible to infer with confidence the amount of GDP that international banks can legitimately support, since historically the performance of sovereign central banks have maintained a reasonable consistency. Thus using the same average leverage ratios derived from above, the ECB could support $685Bn GDP and the IMF could support $3.86Trillion GDP as at Jan 2011 World Gold Council official reserves.
The data for the Eurozone identifies several alternative policy opportunities for the Governing body of the Eurozone, should they elect to behave as a unified cooperative and establish some legally binding long term commitments as a single body. It also highlights what is up for grabs in the event that any permutation of numerous sinister and unworthy motives being postulated in the main stream become realised. Perhaps it is the realisation of the above credit position that is an impediment to certain policy implementations. Who knows.
It further highlights that the UK, US, Japan and China are underweight gold reserves, while the largest components of the Eurozone are sufficiently capitalised (importantly, the above consideration ignored all sovereign debts accumulated).
Using the words provided in the US Treasury Annual Report of 1902, “The mines are thus confirming the gold standard steadily and invincibly. They are creating an inflation of currency which keeps pace with the enterprise and industry of the country”. This was not a one eyed view of the necessary balances of commerce, production and inflation. Contained within the same section of the annual report is very careful consideration to the imbalances caused by not maintaining the flow of gold needed to balance the requirements of the Treasury.
In closing it says – “Yet for the immediate present, and doubtless for a few years at least, the inflow of gold will be in such large measure as to lift the volume of currency to the highest level of all needs of business.” …. fully aware that change would be required if it was not. Somehow, it wasn’t. By 1927 (25 years later) conditions had deteriorated to the point where pre-empting the changing reserve requirement, Roosevelt was advised to confiscate public gold holding to shore up the US Treasury. What an amazing turn of events that was.
From 1980 – In fiscal 1980 the Treasury was required to refund record amounts of maturing securities and to finance a budget deficit of $59 billion and an off-budget deficit of $14.2 billion. These financings were conducted in an atmosphere of extraordinary uncertainty in financial markets. In October 1979 the Federal Reserve announced a major monetary policy shift toward greater focus on the money supply figures and less on interest rates.
Exhibit 23 Deputy Secretary – Treasury presently has no statutory responsibility or authority to regulate the commodities futures markets, although it is a direct participant in the gold markets and has varying degrees of involvement in markets for various kinds of contracts involving future delivery.
How appropriate then for the US in the hour of need, when the additional reserve requirements were needed that the floating gold price should rise in order to shore up balance sheets around the world. The spike of Jan1980 and the subsequent low long afterwards, provided a critical injection of confidence into many sovereign balance sheets that gave us the 1980-2000 bull market. How, it allowed them the surety to expand monetary stock in order to prop up stale economies. No doubt this phenomenon will happen again.
I argue in this 2 part consideration of US Treasury operations since 1900 and continuing past the end of the official ‘gold standard’, that the principal of maintaining physical gold reserves of acceptable proportion to money stock remains an enduring desire as a measure of sovereign credit worthiness. I am mindful that these reserves do not have to be a singular metal, or even gold itself. But barbaric metals are more than capable and have already been verified by precedence. Extrapolation of a universal credit standard is therefore not hard to imagine, even in possession of a suitable alternative should one be provided. The IMF was created along with the SDR, a derivative of credit using a fictitious currency unit that is backed only by the faith and credit of the depositors. The balance sheet of the IMF is created by donations, with the SDR being the currency of the IMF. Am not sure how that is supposed to work.
The details revealed in reading the Annual Reports of the US Treasury in the period 1900 to 1940 are fascinating, and I plan on continuing to read them all. I believe we are living through another déjà vu moment since nothing about the operation of the global credit system has changed since its inception, even long before 1900. There are no more or less advanced controls, nor are there more or less intelligent people manning the guard houses. The motives and motivation behind running simplistic global credit systems on leveraged monetary bases remain the same today as they were in 1800 and again in 1900.
It remains that a physical and tangible standard reserve be required to provide the necessary credibility to any legitimate unit of currency. The charts above elicit an alternative explanation for the events of 2008.
C’est la vie.